ISLAMABAD: Covid-19 is likely to significantly affect Pakistan’s external balance in five ways - reducing exports, foreign investment and remittances, deflating the import bill, and increasing external debt.
All these repercussions of the pandemic come from recession in economy – in part supply-induced and in part demand-induced – across the globe. Pakistan’s top 10 export markets in descending order are the US, China, the United Kingdom, Afghanistan, Germany, the UAE, the Netherlands, Spain, Bangladesh and Italy.
Together, these 10 countries make up 61% of Pakistan’s global exports. With the exception of China and Bangladesh, the economies of all the other eight markets are predicted to contract in 2020.
As per the IMF World Economic Outlook, released in April this year, the US, which is Pakistan’s largest market accounting for 16% of its global exports, will undergo economic contraction of 6.5%.
Likewise, the United Kingdom, which makes up 7.2% of Pakistan’s global exports, will register negative growth of 6.5%. The economies of Afghanistan and Germany, the fourth and fifth largest destinations respectively for Pakistan’s exports, are predicted to contract 3% and 6.9% respectively. The UAE, Netherlands, Spain and Italy will register negative economic growth of 3.5%, 7.5%, 8% and 9.1% respectively.
In China, which is the second largest destination for Pakistan’s exports, economic growth is predicted to sputter from 6.1% in 2019 to 1.2% in 2020. Likewise, the economy of Bangladesh will grow 2%, down from 7.8% in 2019.
As foreign demand is a major determinant of a country’s export performance, a deceleration in economic growth in Pakistan’s top export destinations is likely to cast its shadow on the export revenue. Let’s have a look at Pakistan’s export performance in recent months, year-on-year (YoY). In January 2020, Pakistan’s exports registered a negative growth of 2.78%. However, this can hardly be attributed to Covid-19.
However, in seven months (Jul-Jan) of FY20, exports increased 2.2%. In February 2020 and Jul-Feb FY20, exports went up 13.76% and 3.62% respectively. Likewise in March 2020 and Jul-Mar FY20, exports went up 0.13% and 1.68% respectively. Thus, March drove down the growth in exports, which marked the beginning of the impact. April 2020 saw 54% export growth contraction while during Jul-Apr FY20, 3.9% export drop was recorded.
Full impact yet to come
Since foreign trade orders are placed several months in advance, the full impact of the pandemic on exports will be felt in coming months.
The contraction in exports in April has largely been due to the disruption in domestic supply chains. As Pakistan’s economy is predicted to contract 1.5% in FY20, the size of the exportable surplus will shrink, which will affect the capacity to export. The fall in commodity prices, driven by a steep decline in aggregate demand, will rub salt on Pakistan’s wounds.
Cotton textile accounts for nearly 60% of Pakistan’s total exports. Over the years, fluctuations in the country’s export receipts can largely be set down to the upward or downward movement in prices of cotton.
The outbreak of Covid-19 has struck a blow to international commodities’ — including cotton — prices. From $1.74 per kg in January 2020, average world cotton spot price went down to $1.69 in February and further to $1.49 and $1.40 in March and April respectively.
Thus, in three months, cotton prices have slipped 34 percentage points. Until reversed, the downward movement in prices will adversely affect the countries whose export baskets are dominated by cotton textile. The silver lining for Pakistan is a drastic fall in the price of crude oil. Transportation and industry are the two principal consumers of fuel. The lockdowns and business shutdowns caused the demand for oil to plummet. As a result, the crude prices nosedived to their historic lows.
The price war between two of the world’s largest oil producers and exporters, namely Saudi Arabia and Russia, helped aggravate the lockdown effect. It was then the Organisation of the Petroleum Exporting Countries (OPEC) and non-OPEC oil producers struck a deal to cut the crude’s output by 9.7 million barrels per day in May and June.
The cuts are likely to persist throughout the current year. The reduced supply of and enhanced demand for oil on the back of easing or lifting of lockdowns in several countries will combine to raise the commodity’s price. Buoyed by such signals, Brent, the international crude benchmark, rose 10% to $35.72 per barrel, which is the highest jump in recent weeks. However, it will take a while before oil prices go back to their pre-pandemic levels, which will provide some respite for oil-importing countries like Pakistan.
Oil price effect
Probably helped by the fall in oil prices, Pakistan’s imports fell 34.5% in April 2020 YoY while for Jul-Apr FY20, the cumulative fall in imports was 16.5%.
In Jul-Mar FY20, imports had dropped 16.76% including the 19.85% drop in March 2020. As oil prices are beginning to recover, the succeeding months may see a weakened price effect on the overall import bill.
That said, imports had been on a downward trajectory even before the pandemic struck, largely due to economic slowdown. For example, in Jul-Jan and Jul-Feb FY20, imports compressed 15.64% and 13.81% respectively. Covid-19 has only helped this trend.
As the economy is forecast to contract in 2020, the import demand will come down significantly. In the likely scenario of export contraction, import compression will remain the only means to narrow the trade deficit.
Covid-19 is predicted to strike at a very significant source of foreign exchange – remittances. It is remittances from Pakistani Diaspora that over the years have helped finance the trade deficit.
The demand for labour is derived demand, which depends on the demand for goods and services that workers produce.
As the economies of major sources of remittances for Pakistan, including the Gulf region, Western Europe and the US, shrink, the demand for foreign labour will go down and adversely affect financial contributions from overseas Pakistanis. In case the trade deficit does not significantly narrow, the fall in remittances will jack up the current account deficit (CAD).
An economy’s CAD is financed by its capital transactions or fiscal account, of which foreign direct investment (FDI) is an important source.
In recent years, Pakistan has received meagre FDI inflows. Nearly half of those have come from China under the China-Pakistan Economic Corridor (CPEC). The current financial year, however, has seen a surge in FDI. In the first nine months (Jul-Mar), $2.14 billion in FDI was received compared with $905 million in the corresponding period of last year and $1.66 billion in the full FY19.
However, the global capital crunch is likely to cast its pall over FDI inflows into Pakistan as the country will be competing to attract even scarcer foreign capital. As a result, the economy will have a smaller cushion to finance CAD from non-debt creating instruments, such as FDI, and by implication will become more dependent on foreign credit for its external balance needs.
With the economy shrinking and external debt increasing, the total debt-to-gross domestic product ratio, which reached 93% (98.2%, if we add liabilities as well) at the end of March 2020, will rise.
The writer is an Islamabad-based columnist
Published in The Express Tribune, June 1st, 2020.
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